Is inflation wwweally good for property?

Posted by Mark on 9th Jun 2009
Like many active buyers with cash, we too have recently fallen victim to "free valuation" scam, being perpetrated by certain vendors who feel quite content to let you do a number of weeks detailed work on a purchase only to be coquettishly told that they are no longer sellers.

This spring bounce seems to have got a number of people quite intoxicated and they have once again fallen in love with the assets that they have rarely given the time of day to, let alone asset managed, for the last decade.  Their rose tinted glasses have given a pulchritudinous hue to investments that three months ago they would have "stapled" their nearest and dearest to, to facilitate a sale.

But, vendors should have a weather eye to the cost of finance and the impact over the medium term that this will have on what we are prepared to pay.  Whilst the number of banks willing to lend is undoubtedly on the increase, so is the accepted margin that they feel they can get away with reasonably charge and underneath all of the current mood music is the distant rumbling of inflationary expectations.

Despite the best efforts of the BoE to keep down the yield curve through Quantitative Easing, 10 year gilts now stand higher than when they began the process, 5 year SWAP rates have gone up 50 bps in the last month; for purchasers already struggling justify >20% IRR this is 0.50% onto the initial yield.

But, inflation is good for property, isn't it?

Despite being a child of the seventies, I don't even, unfortunately, remember Sunderland's legendary FA cup win against dirty Leeds, never mind macro-economic factors, but there seems to be an obvious flaw in this logic, certainly in the short term.

Given the dire outlook for rental values over the short term, where pricing power rests solely with the tenants, I just don't see inflation feeding through into rental growth in a meaningful way.  It is certainly conceivable that investment property could be caught between the horns of falling rents and increasing cost of finance, that will rapidly squeeze out the positive yield gap that makes property an attractive proposition.

Why are we still buyers then?  Obviously we believe that we will make more money out of an asset than an incumbent owner who are firefighting on all fronts and our investors are backing us over the medium to long term.  But this is going to be a long slow recovery, with many false dawns and as Mike Slade has wryly observed more of a www shaped recession.

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